CHAPTER 26 Factor Markets: With Emphasis on the Labor Market Chapter 26 is the first of three chapters to focus on the theory and workings of factor markets . Studying factor markets serves two purposes: first, we begin to get a better grasp of what underlies the firm’s cost curves; second, in and of themselves, they provide an interesting study of resource allocation and pricing in a market situation. Chapter 26 begins with some general information on factor markets, the various degrees of market power that firms have as suppliers of goods and demanders of factors, and the appropriate profit-maximizing behavior of firms in the factor market. The chapter then turns specifically to the labor market and discusses the function of the (idealized) labor market under the assumptions of perfect competition and perfect information. The chapter concludes with a discussion of the role of information in the labor market, with specific reference to its effects on hiring, promotion, and discrimination.  CHAPTER OBJECTIVES Upon completing this chapter, your students should be able to: 1. Compute marginal revenue product (MRP) and marginal factor cost (MFC). 2. Derive a factor demand curve. 3. Explain what quantity of resources a firm should buy. 4. Identify what will change the demand for labor. 5. Identify what will change the supply of labor. 6. Explain how wages are determined in competitive markets. 7. Discuss the marginal productivity theory. 8. Discuss employee screening.  KEY TERMS • derived demand • least-cost rule • marginal revenue product (MRP) • elasticity of demand for labor • value marginal product (VMP) • marginal productivity theory • marginal factor cost (MFC) • screening • factor price taker 253

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254 Chapter 26  CHAPTER OUTLINE I.FACTOR MARKETS A.The Demand for a Factor —A firm hires factors of production for one specific purpose: to produce the firm’s product. As a result, the firm’s demand for factors is closely related to the demand for the firm’s output in the product market—that is, the firm’s demand for factors is derived demand , dependent upon the demand for the firm’s product. If the demand for the product rises, the firm’s demand for factors rises; if demand for the product falls, the firm’s demand for factors falls. B.Marginal Revenue Product: Two Ways to Calculate It —Exactly how many additional (fewer) factors should the firm hire/buy if the demand for its product changes? To answer this question, we need two concepts. The first is marginal revenue product (MRP) , the additional revenue generated by employing an additional unit of a factor ; that is, MRP = ∆ TR/ ∆ Quantity of the factor Alternatively, we can calculate MRP using the concept of marginal revenue, such that MRP = MR × MPP X where MPP X , the marginal physical product of factor X, is the additional quantity of output produced by using one more unit of factor X. The two ways of calculating marginal revenue product are illustrated in Exhibit 1. 1.MRP =

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